A mortgagee was the highest bidder at a foreclosure sale that took place shortly before the debtor filed bankruptcy. The lender requested relief from the automatic stay in order to evict the debtor on the basis that transfer of the property was completed prepetition so that it was not part of the debtor’s bankruptcy estate.
The debtor granted the lender a deed of trust to secure a loan. After she defaulted, the lender instructed the deed of trust trustee to commence a non-judicial foreclosure. The trustee held a sale at 10:05 a.m. The lender made a credit bid and was the highest bidder. The debtor filed bankruptcy at 3:35 p.m. that same day. Apparently the lender received a deed that day, but the deed was not acknowledged until five days later. Several days after the trustee’s deed was acknowledged, it was physically delivered to the county for recording.
The debtor continued to reside at the property, and proposed a chapter 13 plan of reorganization that included reinstatement of the deed of trust. The lender objected based entirely on its argument that the foreclosure sale was final prior to the bankruptcy filing so that the property did not become part of the bankruptcy estate.
The court determined that the sole issue was whether the deed transferred ownership prior to the bankruptcy filing. Generally property rights are determined by state law. So the court turned to the applicable state statutes. It began by focusing on two statutory provisions:
- “Every conveyance of real estate, or any interest therein… shall be by deed.”
- “Every deed shall be in writing, signed by the party bound thereby, and acknowledged by the party before some person authorized by this act to take acknowledgments of deeds.”
The court concluded from these provisions that a conveyance is not effective until it is acknowledged. Quoting the state supreme court: “an instrument, in every other respect fully satisfying the requirements of a deed, except the acknowledgment of the grantor, is not yet a deed.”
Since the trustee’s deed was not acknowledged until postpetition, the lender had to come up with some sort of exception to this rule to prevail. The lender turned to the sale section in the foreclosure statute:
[I]f the trustee accepts the bid, then the trustee’s sale is final as of the date and time of such acceptance if the trustee’s deed is recorded within fifteen days thereafter.
Thus, the lender argued that perfection relates back to the date of the sale if the deed is recorded within 15 days; and since the deed was recorded less than 15 days after the filing of the petition, perfection was effective prior to bankruptcy. (Note that under Section 549 of the Bankruptcy Code a trustee can generally avoid post-petition transfers that are not authorized by the Bankruptcy Code. However there is an exception for transfers of an interest in real estate that meet certain criteria, including that the transfer can be recorded so as to perfect it against a bona fide purchaser on the petition date.)
The court countered that the issue was not perfection, but rather whether there was a conveyance in the first place. It pointed to another sentence in the foreclosure statute that read:
Upon physical delivery… the trustee’s deed shall convey all of the right, title, and interest in the real and personal property sold at the trustee’s sale.
To reconcile these two sentences, the court concluded that, although perfection by recording could relate back to the date of the sale, the conveyance itself was not effective until there was physical delivery of a deed. Add the fact that a deed is not a deed until it is acknowledged, it was clear to the court that the conveyance to the lender was not effective until after the bankruptcy filing.
The court rejected contrary cases offered by the lender, finding that there were differences in the facts and/or governing statutes. In particular, not all foreclosure statutes include the clear distinction between when the conveyance is effective and when perfection is effective. If the statute had not included the provision to the effect that a transfer is effective upon delivery of the deed, the lender might have prevailed.
The steps required to bankruptcy proof a foreclosure sale can be tricky and require close analysis of the applicable state statutes. For example, if a foreclosure statute does not include a relation back provision (as was the case here), a foreclosure sale deed will be vulnerable to avoidance if it is not recorded at the time bankruptcy is filed, since it would likely be subject to avoidance using a trustee’s powers as a bona fide purchaser.